Preface: The art and science of the process and set of procedures used to estimate the economic value of a (business) owner’s interest in an enterprise can be likened to an auction for rare collectibles; opinion and values often marginally vary. To achieve a transaction of an enterprise at a set price, two types of contributions must occur 1.) ample enterprise liquidity for business owners, 2.) appealing business opportunity to employ assets for an enterprise investor(s).
Profitability and Business Valuation: Appraisals Are a Prophecy of an Enterprise’s Future Cash Flow Value (Segment IV)
Credit: Donald J. Sauder, CPA | CVA
A restrictive buy | sell agreement is another prime example of why a business valuation could merit a reasonable discount for lack of marketability. An investment asset with lower liquidity has a necessary discount to account for the uncertainty and time commitment to successfully transact the organization. This is the driving purpose of marketability discounts. Marketability discount rates can range from ten to fifty percent depending on the marketplace.
In addition to lack of marketability discounts in valuation, minority discounts can to be necessary for adjusting business values if an interest lacks control of the following: set management compensation, make cash distributions, elect or appointment management, set company policy, or make capital expenditure decisions.
The marketability and minority discount features are commonly omitted in non-accredited valuations and therefore result in a skewed appraisal. Valuation discounts require comparisons to market data and the marketplace environment the accurately determine fair and applicable discounts. Accredited appraisers have the required and necessary valuation tools and market analytics to prepare and substantiate fair market business values more accurately.
Valuation analysts should be appreciated for the reasons included expertise required to accurately analyze fair and adequately documented appraisal value, i.e. the valuation report. This encapsulates appropriate capitalization rates, marketability discounts, minority discounts, goodwill premiums, and other factors that are often elusive to the untrained eye.
A bona fide business appraisal includes all documents for an independent analyst to calculate from comprehensive report data, an independent value for the business. Accredited reports provide clear analyst representations of the business value at the appropriate date of appraisal, including financial statements, analysis, narrative and detail of valuation model and capitalization rates.
The Market Approach to Valuation
Market approaches to valuations apply prior market transactions to determine an enterprise value based upon metrics such as sales multiples or seller’s discretionary earnings multiples. Again, business appraisals should have at least two comparison approaches to triangulate business value accuracy and reasonableness, i.e. market approach and income approach are two common value double checks.
Why is an appraisal a value prophecy? An appraisal is a prophecy to the future value of cash flows of a business to prospective buyers whether that buyer is an internal or external party. Just like stock prices of publicly traded businesses range from day, so do business values for private enterprises. Value range, based on cash flows from operations, risk profile of the investment environment, and characteristics of the business asset.
When an appraisal is necessary for estates, gift taxes, buy | sell transitions and other pertinent business valuation purposes, obtaining an objective, conflict free appraisal requires in-depth expertise and an understanding of specific business industries.
The art and science of the process and set of procedures used to estimate the economic value of a (business) owner’s interest in an enterprise can be likened to an auction for rare collectibles; opinion and values often marginally vary. Yet with appropriate models for financial market participants to determine the price(s) they are willing to pay or receive as a value to achieve a transaction of an enterprise at a set price, contribute to enterprise liquidity for business owners, and a business opportunity to employ assets for enterprise investors.